Court passes judgement on the duty of care of asset managers

On 24 October 2012 the Court of Amsterdam passed judgement on the duty of care of asset managers. The verdict, published on 15 November 2012, can be found through the link on this page.

In this case the Court ruled that the duty of care of an asset manager includes, among other things:

  • The asset manager has the primary responsibility to invest in accordance with the agreed risk profile and the corresponding asset allocation.
  • The asset manager cannot invest outside the mandate without the client’s explicit consent.

How can you, as an asset manager, prevent shortcomings in the duty of care with regard to your clients? In this news item we will look at the verdict and the lessons to be learned.

Infringement of duty of care

The case revolves around the managed assets of a client who has no investment experience. The aim of the management was ‘supplementing annual income from renting and other earnings’ and ‘generating income and asset growth with a limited degree of risk’.

The agreement was that the investments would have a ‘profile between neutral and defensive’ with a long-term horizon. The agreement also mentions that the portfolio will be put together with a risk profile that approaches the neutral model, i.e. 24% bonds, 23.5% market-neutral hedge funds, 26% shares and 26.5% long/short hedge funds.

In the course of time the asset manager replaced the shares and bonds from the portfolio with hedge funds and funds or hedge funds (70.4%). Later the asset manager informed the client by means of a news letter regarding the interpretation of the defensive, neutral and offensive products used. The asset manager divided each profile into two categories, high-risk and low-risk, taking the liberty to exceed the high-risk category of each profile with a maximum of 10%.

The Court states that the asset manager violated her duty of care, because she did not act like a good steward due to investing with too much risk with regard to the asset allocation, the risk profile of the client and the specific personal circumstances of this client. The agreements with the client had not been complied with. The asset manager invested the client’s assets in funds that did not fit the willingness to take risks and the ‘risk-averse’ objective of the client.

Too much high risk investment in unsuitable funds
Summarising, the Court reasons as follows:

  • The asset manager has stepped outside the mandate of the asset allocation with the investments. Based on the intake form a risk profile between neutral and defensive was agreed upon. The sole fact that the asset manager informed the clients with a news letter and portfolio surveys, and that the client did not ask any questions, does not mean that the client tacitly agreed with the asset manager’s changed policies. The asset manager has the primary responsibility to invest in accordance with the agreed risk profile and the corresponding asset allocation. Certainly when for a significant part riskier investments are to be made the client’s explicit consent is required, in which case the client must be made aware in understandable language, of the implications and risks of the modified policy.
  • In general, hedge funds qualify as high-risk. Due to the limited transparency it is often unclear what the fund ultimately invests in. The investments are often illiquid and more difficult to evaluate and the asset manager often has no influence on the (complex) strategy of the funds. These risks apply all the more for investments in funds or hedge funds.
  • The asset manager should have applied more risk spreading. In view of the risk of investing in (funds or) hedge funds, the personal situation of the client and the agreed risk profile, the asset manager should have under no circumstances invested 50% or more of the assets in such high-risk funds.
  • The client was insufficiently informed. As the expert party the asset manager could furthermore have been expected to inform the client in a clear, understandable and comprehensible way about the characteristics and risks of this type of investment.

Based on these considerations the Court reached the conclusion that the asset manager did not manage the assets as a good steward and that she has accountably failed in the duty of care she has regarding the implementation of the asset management agreement.

The importance of investing in accordance with the risk profile of your client

For the duty of care of the asset manager the know-your-client-principle is very important. The asset manager needs to acquire enough information from/about the client concerning his/her financial position, knowledge, experience, objectives and risk willingness. This information is the basis of the client profile. The asset manager has to take this information into account (visibly) when performing her duties. The client profile has to fit the risk profile and the corresponding portfolio (demonstrably).

The risk profile cannot be adjusted unilaterally by the asset manager, and certainly not in case of higher risk investments. To that end the asset manager needs the explicit consent of the client and prior to the amendment the asset manager must inform the client in clear and comprehensible terms about the characteristics and the risks of the investments. This applies all the more when the client does not have any investing experience and is therefore not capable of making their own sound assessment of the risks involved.

What are the lessons to be learned from this verdict?

In itself the Court verdict is in line with previous verdicts concerning the duty of care surrounding investments that go beyond the mandate. For an asset manager it remains of the utmost importance to ensure that a client’s portfolio is in keeping with the agreed risk profile of the client. This means that the asset manager draws up a correct and complete client profile on the basis of the information obtained from the client, including financial position, knowledge, experience, objectives and risk willingness.

From the information obtained it needs to be established whether or not the services offered by the asset manager are in general terms in keeping with the client. When this is the case the asset manager then needs to provide suitable advice and a risk profile. In addition any eventual investments and corresponding risks will have to be (and remain) in keeping with the client’s risk profile.

For an explanation of the building blocks of the systematic of putting together client and risk profiles we refer you to our news item of 5 March 2012, with an analysis of a similar verdict by the Court of Amsterdam in the framework of a violation of the duty of care.

Quick scan by Charco & Dique

To help you quickly assess whether or not the verdict of the Court of Amsterdam has an impact on your organisation we have developed a quick scan. With this quick scan Charco & Dique can help you evaluate whether your company’s system meets the minimal (legal) requirements.

During this quick scan we will assess, among other things, how you reached your investment policy and the corresponding risk profiles, the way the client is informed about the risk profiles and how you guarantee that a client profile is (and remains) in keeping with the risk profile.

In addition, we will discuss with you how you can ensure that periodical or continuous monitoring of portfolios takes place in relation with agreed risk profile/investment policy. Ideally a policy has been formulated for the frequency of monitoring, what to do in case of deviations, contact or no contact with the client, et cetera.

Furthermore the client profile will have to be updated regularly. Alignment of the client profile is not a one-off exercise, but needs to be evaluated regularly. We are happy to discuss with you how you can guarantee this.

For more information, please contact us by calling +31(0)20-4165403 or e-mail address